Environmental risk & responsibility and insurance arrangements for the NSW CSG industry

NSW Chief Scientist & Engineer

May 2014

Chief Scientist and Engineer GPO Box 5477, Sydney NSW 2001, Australia | Tel +61 2 9338 6786

www.chiefscientist.nsw.gov.au

30 May 2014 The Hon Michael Baird MP Premier Minister for Infrastructure Minister for Western Sydney Parliament House SYDNEY NSW 2000 Dear Premier, Environmental risk and responsibility and insurance arrangements for the NSW Coal

Seam Gas industry As the Independent Review into Coal Seam Gas Activities in NSW has progressed an issue which has been raised by concerned stakeholders relates to the adequacy of insurance coverage for the CSG industry in the event of associated impacts to the environment. To further investigate this issue I commissioned a background study on insurance options for the industry and a peer comment paper. A covering summary report prepared by my office contains one recommendation for the Government’s consideration. In presenting this paper I wish to acknowledge the assistance of Hicksons Lawyers and Piper Alderman for their work in studying this complex matter. Yours sincerely Mary O’Kane NSW Chief Scientist and Engineer

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EXECUTIVE SUMMARY

As part of the independent Review into Coal Seam Gas activities in NSW, a paper was commissioned which responds to informal advice that the CSG industry in NSW is poorly insured for environmental impacts. The paper, authored by Hicksons Lawyers, examined ways in which insurance coverage could be improved along with a range of other measures to deal with environmental risk in the industry. The study and subsequent peer comment paper also commissioned by the Review fall under the second term of reference for the Review: “identify and assess any gaps in the identification and management of risk arising from coal seam gas exploration, assessment and production, particularly as they relate to human health, the environment and water catchments” (see Appendix 1 for full terms of reference).

Informal advice from insurance industry sources in Australia indicates that traditionally oil and gas companies have a higher risk appetite than other large industries. This means they generally take on their own risk, that is, self-insure or underinsure. Companies may take out general liability insurance to address a broad range of risk, or a public liability policy to focus on material damage such as third party injury or property damage. Some may take out insurance to cover sudden and accidental pollution, such as a well cover policy.

However, it is broadly acknowledged that in NSW when it comes to CSG companies, take-up of such coverage is uneven at best. It is also recognised by both industry and government that there is no mechanism to address unforeseen and/or long term environmental impacts potentially attributed to these gas extraction activities.

Indeed, broadly there has been a lag in awareness about protection for environmental damage in this country and advice suggests industry players have only recently started showing an interest in more comprehensive forms of pollution insurance. This is probably due to the fact that in Australia there hasn’t been lengthy industrial experience on the scale of industry growth and expansion in the U.S. In NSW, coal seam gas extraction is a relatively new industry and it is one which is largely unprotected.

The Review was therefore interested in examining how a more robust risk management and insurance system could strengthen environmental standards, accountability and performance of industry and minimise risk to government and the people of New South Wales. Critically, information on a more comprehensive model which would help address potential long-term environmental impacts and remediation on, and beyond, licensed land parcels was sought.

The Hicksons paper acknowledges there is no CSG industry standard approach to insurance and puts forward a number of insurance policy options for consideration to strengthen the insurance coverage of CSG industry participants operating in NSW. The paper also notes there are comprehensive pollution legal liability insurance products available on the market suitable for the CSG industry.

Following submission of the paper, the Review then sought peer comment on the paper from law firm Piper Alderman which produced its own paper fleshing out an appropriate risk identification framework, and arguing that more diligent environmental investigation and assessment of CSG proposals at the application stage should be adopted to minimise future claims.

While there are differences in focus, both papers agree an improved insurance coverage regime would be beneficial to the State and both support the concept of a rehabilitation fund similar to the special purpose fidelity fund set up by the Western Australian Government for mine rehabilitation. Establishment of such a fund would enable an additional layer of

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coverage and be beneficial to government in the event of long term or unforeseen environmental impacts caused by CSG activities. The fund would represent a third layer of protection in addition to the security deposit process and any new or enhanced insurance arrangements required by Government, with each layer addressing separate risks as outlined in the conclusion of this paper.

The two papers and terms of reference can be found at Appendices 2 and 3.

The examination conducted by the Review is not exhaustive but raises the issue so that more work can be done. Accordingly, the recommendation of this report is for further consideration by the appropriate government agencies of the issues raised.

ISSUES RAISED IN PAPERS (HICKSONS AND/OR PIPER ALDERMAN)

• Concern that a relatively new but fast-growing industry in NSW which does not have the same strict insurance requirements (as, for example, the offshore petroleum industry) has resulted in an underinsured industry.

• Insurance taken up tends to be third party liability coverage which protects third parties but not the insured and does not extend to natural resource damage.

• There is no requirement in the legislation for insurance although this can be included as a licence condition at the Minister’s discretion (however evidence suggests this has not been required to date).

• Financial assurance which covers bonds, guarantees, insurance, sureties, indemnities etc. is ultimately at the discretion of the department as to how it is required and supervised, and could expose government to unnecessary risk if not adequately regulated.

• Security deposits typically only cover the cost of on-site rehabilitation at cessation of operations, not beyond the tenement or any long term impacts.

• Comprehensive pollution legal liability insurance policy is now available in the market which covers pollution and natural resource damage on and off site.

• Western Australia Mining Rehabilitation Fund cited as a good model for government to pursue in the form of a CSG rehabilitation fund and to maximise coverage for long term and unforeseen environmental impacts.

• Strengthening the environmental risk assessment of projects at application stage should be given appropriate consideration.

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RECOMMENDATION

It is recommended the NSW Government notes the attached reports and refers the matter to NSW Treasury for further examination, in consultation with NSW Trade & Investment and the NSW Department of Planning and Environment, to consider a robust and comprehensive policy of appropriate insurance and environmental risk coverage for the CSG industry. This consideration should examine the potential adoption of a three-layered policy of security deposits, enhanced insurance coverage and an environmental rehabilitation fund administered by government. Consideration of how any additional insurance or levy is calculated would need to take into account the level of risk associated with the different stages of any proposed coal seam gas development activity.

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Contents Executive summary ..................................................................................................................... iii

ISSUES RAISED IN PAPERS (HICKSONS AND/or PIPER ALDERMAN) ................................................ iv

Recommendation ........................................................................................................................ v

1 Introduction ......................................................................................................................... 1

2 NSW rehabilitation security deposits ..................................................................................... 2

3 Insurance arrangements in other jurisdictions ....................................................................... 3

3.1 Alberta, Canada ................................................................................................................... 3

3.2 Colorado, U.S.A. .................................................................................................................. 4

3.3 Western Australia ............................................................................................................... 4

3.4 The concept of an environmental fund .............................................................................. 5

4 Conclusion ............................................................................................................................ 7

5 Recommendation ................................................................................................................. 8

6 References ........................................................................................................................... 9

Appendices ................................................................................................................................ 10

Appendix 1: Terms of Reference for Independent review of coal seam gas activities in NSW by Chief Scientist & Engineer

Appendix 2: “Insurance and Environmental Securities”, by Bernard Evans, Hicksons Lawyers

Appendix 3: Peer Comment on “Insurance and Environmental Securities”, by Tony Abbott, Piper

Alderman

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1 INTRODUCTION

Throughout the independent review into coal seam gas activities, the Review team has heard, through its consultation with community, concerns about the potential for environmental incidents and the long term impacts of CSG activity on the environment. These concerns have understandably arisen in response to notable oil and gas related environmental incidents around the world, and in relation to the early problems associated with CSG extraction in the U.S. The natural question to follow concerns expressed around regulatory strength and monitoring, is around the level of coverage and the financial capacity of companies to manage the repercussions of such an incident should it occur. Informal advice to the Review indicated that the CSG industry is underinsured. These concerns led the Review to examine the issue of industry insurance via a commissioned paper authored by Hicksons Lawyers and a peer comment paper authored by Piper Alderman. Both law firms have experience in matters relating to oil and gas regulation and activity in Australia, but indicated at the time of commissioning that neither had a conflict of interest in terms of having clients who were NSW-based companies engaged in coal seam gas activities.

Following the submission of both papers it became clear to the Review that there are three levels of issues which require different insurance or risk coverage approaches, as summarised in the conclusion of this paper. First, companies must be insured against known risks and expected costs of projects. Second, companies also need to be insured against any sudden accidental pollution events as a direct result of their operations on or near the tenement. Finally, as this paper posits, there is a strong argument for a third level of coverage to be examined by government which addresses any potential long term environmental impacts associated with CSG activity. The latter is, of course, a largely untested area in NSW and while the technology around CSG extraction is well established, the application and impacts of this technology in relation to the distinct geography and geology of NSW is not. That is to say that CSG is a relatively new industry in this State and it would be in the Government’s best interests to explore further the matter of environmental risk and responsibility until it is satisfied of a robust and appropriate policy approach.

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2 NSW REHABILITATION SECURITY DEPOSITS

Under NSW legislation the holding of insurance is not mandatory however the conditions of a licence may require the licence holder to take out and maintain a policy of insurance. Such a policy should provide cover for the payment of costs for clean-up action, and for claims for compensation and damages resulting from pollution in connection with the activity or work authorised or controlled by the licence. The use of such a licence condition does not seem to have been used. Financial assurance is referred to many times in the Protection of the Environment Operations Act 1997 but not as a mandatory condition and there are no explicit guidelines for use by the relevant regulatory bodies in relation to assessment of financial assurance. Evidence of an applicant’s financial standing is sought under the Petroleum (Onshore) Act 1991 as an accompaniment to a title application and can often simply constitute a letter of endorsement from a chartered accountant. Again the guidelines for use are not specified within the legislation and interpretation is at the discretion of the Minister’s delegate, that is, generally, the Division of Resources & Energy or the Office of Coal Seam Gas (OCSG).

Under the Petroleum (Onshore) Act 1991 the current process in NSW includes the requirement that all titleholders engaged in mineral and petroleum exploration, assessment and production activities, lodge a security deposit with the Government on issue of title. The security deposit is to cover the Government’s full costs of rehabilitation of the land subject to the title and incudes any dams or roads under the title. The security deposit is provided by way of bank guarantee or cash and is regularly reviewed by the OCSG.

The amount of the security deposit required is determined by an estimate of rehabilitation costs provided by the titleholder and reviewed by the OCSG which has access to the expertise of an internal quantity surveyor and/or can request a third party review of costs if deemed necessary. Rehabilitation cost estimates are required to include an additional 20% to allow for project management costs and contingencies. The OCSG on behalf of the Minister for Resources & Energy is responsible for determining when the rehabilitation has met the required standard, taking into account adherence to the titleholder’s rehabilitation and closure plan, legal obligations and the future use of the site.

If the obligations for rehabilitation have not been met to the satisfaction of the OCSG, part or all of the security deposit can be forfeited for use by the Government to meet rehabilitation requirements (Government of New South Wales, 2012).

In coal seam gas activities the rehabilitation work undertaken by titleholders during and at the end of activities is usually limited to plugging and abandonment of wells, and maintenance and removal of surface infrastructure associated with the extraction operations. The rehabilitation security deposit process does not apply to pollution events, which are pursued separately as breaches of legislation by the regulator, the Environment Protection Authority (EPA).

The OCSG advises the security deposit system historically has worked well for its purpose and in the majority of cases titleholders are compliant with the rehabilitation requirements. However, the OCSG does concede there is a gap in policy which does not address long term or unforeseen environmental impacts and that company liability cover and insurance is a difficult space to regulate.

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3 INSURANCE ARRANGEMENTS IN OTHER JURISDICTIONS

On examination the Review has determined that there is no single preferred policy package of insurance coverage in locations with an active CSG industry around the world. Indeed, other jurisdictions have adopted a range of different measures and requirements including those described briefly below.

3.1 ALBERTA, CANADA

3.1.1 Alberta Energy Regulator’s Liability Programs The Alberta Energy Regulator (AER) has the Licensee Liability Rating Program (LLR), Large Facility Liability Management Program (LFP) and the Oilfield Waste Liability (OWL) program. These are designed to minimise risk to the Orphan Well Fund, see section 3.1.3 below, and to help prevent Albertans from acquiring the costs to suspend, abandon, remediate or reclaim wells, pipelines and facilities (Alberta Energy Regulator, 2014).

The programs rate a company’s deemed assets and liabilities and assess security deposits to all companies below a 1:1 ratio. Several directives clearly spell out exactly how these assets and liabilities are calculated, using a variety of provincial standards. If a company feels these standards do not accurately apply to their assets, they can obtain site specific assessments for all of their holdings and use these estimates instead. The program also rewards reclamation awaiting vegetative regrowth with a 50% reduction in fees assessed, thus encouraging companies to complete reclamation requirements as quickly as possible (Alberta Energy Regulator, 2014).

A recent review of the Licensee Liability Rating Program increased many of the costs. A review by Blake legal firm indicated under the new rules, 248 licensees will be required to post security of C$297 million, up from the 88 licensees previous deposits of C$13 million (Bourassa & Zahara, 2013).

3.1.2 Insurance A licensee must have reasonable and appropriate insurance coverage (and maintain the insurance coverage) that is appropriate for the size of the company and the operation that the company carries out. The insurance policy must be issued from a company registered in Alberta to provide insurance in Alberta. Before the AER approves a Licence Eligibility Type to hold AER licences or to become an agent, it requires “evidence of insurance either in the form of a certificate of proof of insurance or a statement of the insurer describing the coverage, effective date, and termination date of the insurance” (Energy Resources Conservation Board, 2005).

“Licensees holding domestic water well licences for wells drilled expressly as water wells are exempt from insurance requirements. However, licensees converting wells drilled by the industry to domestic water well production are required to carry reasonable and appropriate insurance” (Energy Resources Conservation Board, 2005).

3.1.3 Orphan Well Fund The Orphan Well Association (OWA) is a non-profit organisation in Alberta that deals with cleaning up orphaned wells. It is funded primarily through the Orphan Well Levy collected by the AER. The OWA set an annual budget requirement, which the AER then collects from companies based on their proportionate share of industry liability in the LLR and OWL programs. Levy calculations are all comprehensively outlined in AER Directives, and the

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Orphan Well Association clearly outlines what work is being done with the funds, including naming defunct companies (Orphan Well Association, 2012).

3.2 COLORADO, U.S.A.

3.2.1 Surety bonds The Colorado Oil and Gas Conservation Commission (COGCC) prefers a surety bond, backed by a Commission-approved company, for financial assurance, however other forms may be approved separately. Surety bond requirements are based on proposed company activity, including a single bond amount of $10,000 per well for wells less than 3,000 feet (~914m), or $20,000 per well for wells deeper than 3,000 feet (Rule 706, Colorado Oil & Gas Conservation Commission, n.d.). However, statewide blanket financial assurance allows $60,000 for less than 100 wells or $100,000 for drilling and operation of 100 or more wells (Colorado Oil & Gas Conservation Commission, n.d.). Some see this blanket amount as unacceptably low and an incentive for larger companies to lessen the amount of financial assurance with each additional well drilled (Dutzik, Davis, Van Heeke, & Rumpler, 2013).

Allowing for transparency, the public may search online for the type and amount of financial assurance individual companies have on COGIS, the COGCC database at http://cogcc.state.co.us/cogis.

3.2.2 Insurance Colorado requires all operators to carry general liability insurance in the amount of $1 million per occurrence, including property damage and bodily injury to third parties. Additionally, operators must include the COGCC as a ‘certificate holder’ on the policy “so that the Commission may receive advance notice of cancellation” (Rule 708, Colorado Oil & Gas Conservation Commission, n.d.).

If an operator’s financial assurance is called, the amount is deposited in the Oil and Gas Conservation and Environmental Response Fund (CERF). Additionally, a 10% fund recovery fee for any additional overhead costs will be charged on remaining financial assurance. Further, until the operator replaces the balance of financial assurance, the COGCC does not allow the operator to sell gas or oil. Finally, financial assurance third party providers become an ‘unacceptable provider’ and must apply for an order of re-instatement if penalised (Rule 709, Colorado Oil & Gas Conservation Commission, n.d.).

3.2.3 Oil and Gas Conservation and Environmental Re sponse Fund As mentioned above, besides surety bonds and general liability insurance, the COGCC oversees the Oil and Gas Conservation and Environmental Response Fund, which allocates a two year capped amount of $6 million (Rule 710, Colorado Oil & Gas Conservation Commission, n.d.) to:

investigate, prevent, monitor, or mitigate conditions that threaten to cause, or that actually cause, a significant environmental impact on any air, water, soil, or biological resource; to gather background or baseline data on any air, water, soil, or biological resource that the commission determines may be so impacted by the conduct of oil and gas operations; and to investigate alleged violations…that threaten to cause or actually cause a significant adverse environmental impact (Intermountain Oil and Gas BMP Project, n.d. citing §34-60-124 of Oil and Gas Conservation Act).

3.3 WESTERN AUSTRALIA During the Review consultation, the Chief Scientist & Engineer met with the former Premier of Western Australia, the Hon Geoff Gallop AC, to discuss the matter of industry risk and insurance as it applied to the mining industry, who recommended looking to the example of

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Western Australia. The Review of the Project Development Approvals System chaired by Dr Michael Keating AC in 2002 strongly supported enhancing the concept of sustainability as a key aim of developments, recommending a suite of policy initiatives based on this principle. The former Premier indicated that this approach towards more sustainable and accountable development projects, over time and through the actions of successive governments, led Western Australia to develop the Mining Rehabilitation Fund.

3.3.1 Mining Rehabilitation Fund From 1 July 2014 industry participation in the Western Australian Government’s Mining Rehabilitation Fund (MRF) becomes compulsory.

The Western Australian Government established the fund to address the inadequacy of the State’s security bonds system which has not been able to cover the true cost of rehabilitating abandoned mines. Bonds are also seen as problematic in that they tie up significant funds which could be invested in mining projects and as each bond is only applied to a specific mine, it can’t be used to address the long term problem of legacy abandoned mines (Government of Western Australia, 2013).

The MRF provides a pooled fund, levied according to the environmental disturbance existing on a tenement as reported annually (Government of Western Australia, 2013).

The fund is used for rehabilitation where the operator fails to meet rehabilitation obligations and funds cannot be recovered from the operator by other available methods. The model was adopted following consultation with industry, government and community stakeholders (Government of Western Australia, 2013).

Significantly the fund will enable the Government to manage and rehabilitate abandoned mines.

As argued in the Hicksons paper and supported by the Piper Alderman paper, a similar fund applied to the CSG industry in NSW could address issues of long term and/or unforeseen environmental impacts, although rather than replacing the security deposit regime it is proposed such a fund would provide an additional layer of protection in the existing system. This fund would complement the security deposit system and any new or enhanced industry insurance arrangements the Government may require.

3.4 THE CONCEPT OF AN ENVIRONMENTAL FUND The concept of applying industry fees to a government administered environmental fund is not new. In NSW the following programs rely, in part, on funds from industry to address environmental remediation, conservation and efficiency measures and public awareness.

3.4.1 Derelict Mines Program Derelict mines are former mining sites requiring rehabilitation where no individual or company can be held responsible for their management or rehabilitation. During 2012-13 the Division of Resources & Energy undertook rehabilitation works or investigations at 25 sites across NSW. The NSW Government has allocated $4.3 million for the rehabilitation of derelict mines for the 2013-14 financial year.

The range of rehabilitation works funded by the Derelict Mines Program includes detailed site assessments, reduction of safety hazards by fencing and filling shafts, management of water and sediment movement, acid mine drainage management, monitoring and revegetation of the sites. Rehabilitation work has been undertaken in many areas of the state.

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3.4.2 NSW Climate Change Fund The NSW Climate Change Fund was established in 2007 under the Energy and Utilities Administration Act 1987 and is now administered by the NSW Department of Planning and Environment. The fund provides direct support to homes, businesses, government, schools and community organisations to implement measures to save water and power so as to reduce utility bills. The fund also provides support for emerging and proven clean energy technologies in NSW.

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4 CONCLUSION

In light of the work undertaken the Review suggests it is in the best interests of the State and its people to ensure the appropriate levels of industry coverage are available and taken up by industry. Based on a better understanding of international practices and the apparent gaps in the system in NSW the Review notes that there are three primary levels of risk which need to be addressed in this regard:

1. Expected Costs Security deposit (industry to Government) – upfront cash/bank guarantee

2. Sudden accidental pollution Insurance coverage (industry) e.g. so-called ‘cover of well’ insurance

3. Unforeseen and long term costs Environmental fund (industry to Government) – addresses government cost associated with unforeseen and long term impacts including in the event of well abandonment or company insolvency.

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5 RECOMMENDATION

It is recommended the NSW Government notes the attached reports and refers the matter to NSW Treasury for further examination, in consultation with NSW Trade & Investment and the NSW Department of Planning and Environment, to consider a robust and comprehensive policy of appropriate insurance and environmental risk coverage for the CSG industry. This consideration should examine the potential adoption of a 3-layered policy of security deposits, enhanced insurance coverage and an environmental rehabilitation fund administered by government. Consideration of how any additional insurance or levy is calculated would need to take into account the level of risk associated with the different stages of any proposed coal seam gas development activity.

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6 REFERENCES

Alberta Energy Regulator. (2014). Liability Management: Frequently Asked Questions. Retrieved March, 2014, from http://www.aer.ca/abandonment-and-reclamation/liability-management/frequently-asked-questions

Bourassa, Kelly, & Zahara, Ryan. (2013, 30 September ). Increases to Alberta Licence Liability Rating Program. Retrieved March, 2014, from http://www.blakes.com/English/Resources/Bulletins/Pages/Details.aspx?BulletinID=1811

Colorado Oil & Gas Conservation Commission. (n.d.). 2 CCR 404-1, et seq.: Retrieved from http://cogcc.state.co.us.

Dutzik, Tony, Davis, Benjamin, Van Heeke, Tom, & Rumpler, John. (2013). Who pays the costs of fracking? Weak bonding rules for oil and gas drilling leave the public at risk: Environment America Research & Policy Center.

Energy Resources Conservation Board. (2005). Directive 067: Applying for Approval to Hold EUB Licences. Alberta, Canada: Energy Resources Conservation Board (now the AER).

Government of New South Wales. (2012). Rehabilitation Security Deposits. (EDP11 - Version 1.1). Retrieved from http://www.resourcesandenergy.nsw.gov.au/__data/assets/pdf_file/0020/96104/EDP11-Policy-Rehabilitation-Security-Deposits.pdf.

Government of Western Australia. (2013). Mining Rehabilitation Fund: Fact Sheet, October 2013. In Department of Mines and Petroleum (Ed.). http://www.dmp.wa.gov.au/documents/Mining_Rehabilitation_Fund_Fact_Sheet.pdf.

Intermountain Oil and Gas BMP Project. (n.d.). Colorado Laws. Retrieved October, 2013, from http://www.oilandgasbmps.org/laws/colorado_law.php

Orphan Well Association. (2012). List of Defunct Licensees and Expenditures (Alphabetically). http://www.orphanwell.ca/List%20of%20Defunct%20Companies_by_company.pdf.

APPENDICES

APPENDIX 1 TERMS OF REFERENCE FOR INDEPENDENT REVIEW OF COAL SEAM GAS ACTIVITIES IN NSW BY CHIEF SCIENTIST & ENGINEER

At the request of the NSW Government, the NSW Chief Scientist and Engineer will conduct a review of coal seam gas (CSG) related activities in NSW, with a focus on the impacts of these activities on human health and the environment.

The Chief Scientist and Engineer is to:

1. undertake a comprehensive study of industry compliance involving site visits and well inspections. The Chief Scientist's work will be informed by compliance audits undertaken by regulatory officers, such as the Environment Protection Authority and other government agencies

2. identify and assess any gaps in the identification and management of risk arising from coal seam gas exploration, assessment and production, particularly as they relate to human health, the environment and water catchments

3. identify best practice in relation to the management of CSG or similar unconventional gas projects in close proximity to residential properties and urban areas and consider appropriate ways to manage the interface between residences and CSG activity

4. explain how the characteristics of the NSW coal seam gas industry compare with the industry nationally and internationally

5. inspect and monitor current drilling activities including water extraction, hydraulic fracturing and aquifer protection techniques

6. produce a series of information papers on specific elements of CSG operation and impact, to inform policy development and to assist with public understanding. Topics should include: • operational processes • NSW geology • water management • horizontal drilling • hydraulic fracturing (fraccing) • fugitive emissions • health impacts • wells and bores • subsidence.

The NSW Chief Scientist & Engineer will provide an initial report to the Premier and the Minister for Resources and Energy on her findings and observations by July 2013.

APPENDIX 2 “INSURANCE AND ENVIRONMENTAL SECURITIES ”, BY BERNARD EVANS, HICKSONS LAWYERS

Paper 1 - Insurance and Environmental Securities

Hicksons Lawyers Level 32, 2 Park Street, Sydney NSW 2000 Australia DX 309 Sydney t: +61 2 9293 5311 f: +61 2 9293 5333 www.hicksons.com.au SYDNEY · CANBERRA · NEWCASTLE MELBOURNE

Paper 1 - Insurance and Environmental Securities

1. Introduction

In this paper I consider in outline current practice and arrangements for insurance

in the coal seam gas (CSG) industry and also consider some ways in which that

coverage could be improved in the interests of government, landholders, the

broader public and the industry itself (see Part 4)1.

Security deposits are a feature of mining, petroleum and environmental legislation

throughout Australia. Part 10A of the Petroleum (Onshore) Act 1991 (NSW) (the

POA) includes a typical set of provisions. Some comments on these and similar

“financial assurance” provisions are included in Part 5.

Insurance coverage and the provision of security deposits are not unrelated

issues. In this paper I will consider their inter-relationship and the possibility of

establishing a CSG rehabilitation fund of the kind recently established in Western

Australia for the mining industry (see Part 6).

The objective of the paper then is to give an overview of various risk management

techniques with a particular focus on protecting Government from the risk of

operator default.

Before dealing in detail with each of the matters above I include an Executive

Summary (Part 2) and some preliminary recommendations (Part 3).

2. Executive Summary

• We are advised existing insurance practice and arrangements are

inadequate and that, as a rule, CSG operators in New South Wales are

under-insured (relying on often inappropriate third party liability policies) or

are effectively not insured at all (see generally Part 4).

• A more comprehensive form of pollution legal liability insurance is now

available in the market to cover pollution and natural resource damage both

on-site and off-site and for the benefit of the insured (generally the title

holder or operator), third parties, and contractors. One advantage of such

insurance is that gradual, long term loss and damage, for example to

groundwater, can be covered. Another advantage, especially for

Government, is that clean-up costs, whether undertaken voluntarily to

_____________________________________________________________________ 1 In preparing this paper and in particular the sections dealing with insurance I acknowledge the

assistance of Lionel Mintz, Environmental Manager, Asia Pacific Region, Marsh.

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comply with a licence condition or mandated by a Government agency, can

also be covered.

• Such insurance is not mandated under relevant legislation, although at a

Minister’s or other decision maker’s discretion insurance can be included as

a licence condition.

• Security deposits typically only cover the cost of on-site rehabilitation and

closure (extending in some instances to immediately adjacent properties)

and arguably are better suited to mining (and even conventional oil and gas

operations) than CSG operations where the environmental damage is

perhaps more likely to extend beyond a particular tenement or adjacent

properties.

• “Financial assurance” (a broad term covering bonds, guarantees,

insurance, sureties, indemnities and other forms of security) provides some

more flexibility for operators but unless properly supervised could expose

Government to unnecessary risk.

• A special purpose fidelity fund modelled on the recently established

Western Australian Mining Rehabilitation Fund could well provide

Government with the best means of covering the costs of remediation and

rehabilitation of off-site damage caused by CSG operations.

3. Recommendations

I have attached a table to this paper (Attachment) which lists the various security

and risk management techniques which I think are presently and potentially

available to deal with environmental risk and liability caused by CSG operations.

By reference to selected criteria, including:

• level of risk for Government

• administrative burden and complexity

• acceptance by industry

• stakeholder coverage

• coverage of past incidents

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• coverage beyond a tenement or site

• capacity to reward good oil field and environmental practices

• risk identification (a criterion I explain in a footnote on page 1 of the

Attachment),

I have considered how best these risks and liabilities can be met.

My preliminary conclusions and recommendations, in order of preference, are set

out below:

(a) A CSG rehabilitation fund (the Coal Seam Gas Rehabilitation Fund) be

established similar to the Mine Subsidence Compensation Fund and the

Western Australian Mining Rehabilitation Fund which would have the

following features:

• Coverage for remediation and rehabilitation caused by CSG

operations which are “orphaned”, that is not covered by security

deposits currently determined by the Office of Coal Seam Gas

(OCSG). (The terms “orphaned” and “orphan” are used in this

context to describe a well (and well site) which has not been

“abandoned” according to petroleum industry usage, that is properly

plugged and sealed and well out of harm’s way, but rather

abandoned according to common usage).

• Coverage for on-site remediation and rehabilitation of existing CSG

operations (but possibly only if the current security deposit system is

terminated).

• Coverage for off-site remediation and rehabilitation including

groundwater contamination and other long term, gradual onset

damage (e.g., damage to farmland and waterways caused by

produced water).

• It will be evident from the above that a distinction will need to be

made, so far as it is possible, between on-site and off-site

remediation and rehabilitation and that if the security deposit system

is retained (see para (c) and Part 5 below) that system might

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appropriately be confined to damage directly caused by CSG

operations at or near a site (say within the cleared area around a

well or a little further) and include damage to the surface and sub-

surface (so far as damage to the latter can in fact be identified) as

well as failure to follow acceptable and agreed standards in well

construction, operation and abandonment.

• Levy calculation to be determined by reference to risk factors and

possibly including an exemption for low risk, small value exploration

activities. (The Western Australian model should offer some

guidance in this regard.).

• The calculation of the levy may be the most difficult aspect of the

proposed rehabilitation fund. There is little certainty about it,

although given the relative immaturity of CSG exploration in New

South Wales it may not be too difficult to calculate the cost of

remediation and rehabilitation of “orphan” wells and well sites in this

State. More difficult will be the task of calculating the levy for

planned and future operations. On the one hand, it is evident that

good engineering practices supported by effective monitoring and

regulation, in the management of produced water and in drilling,

completing and abandoning wells, can substantially reduce, even

eliminate, environmental risk. On the other hand, there are still

areas where knowledge is incomplete and prediction is uncertain

including groundwater connectivity, chemical contamination and

fugitive emissions. Further, in areas of greater uncertainty the

potential liability of operators may also be considerably higher or at

least that may be the concern. A realistic approach then, as I see it

consistent with the application of the “precautionary principle”2, may

be not to predict or even assume worst case scenarios and levy

heavily but rather build up a fund with a target amount (adjustable

_____________________________________________________________________ 2 There is a large body of literature and (to a lesser extent) case law regarding the so-called “precautionary principle”. It is

also expressed in several different ways but for the purposes of this paper I refer to section 6(2)(a) of the Protection of the Environment Administration Act 1991 (NSW) (the PEAA) where the principle is expressed as follows:

6(2)(a) the precautionary principle - namely, that if there are threats of serious or irreversible environmental damage, lack of full scientific certainty should not be used as a reason for postponing measures to prevent environmental degradation. In the application of the precautionary principle, public and private decisions should be guided by: (i) careful evaluation to avoid, wherever practicable, serious or irreversible damage to the environment, and (ii) an assessment of the risk-weighted consequences of various options,

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as the industry grows and as CSG operational data and knowledge

of actual risk improves) but which also recognises the following

principles:

- operators can be levied at different rates according to their

history and performance record ( if any)

- good performance should be rewarded

- the levy could wholly or partially replace the security bond

system, which should mean it will be acceptable to industry

(as I understand the Western Australian experience has

already shown)

- the rehabilitation fund itself could serve a quasi-regulatory

function in much the same way as does an insurer’s refusal

to provide or renew insurance or charge a higher premium

- income of the fund to be available for orphan wells / well sites

and for monitoring and preventative work

- no relaxation in operator standards and obligations (possibly

including an obligation to carry adequate and appropriate

insurance) and a clear understanding that the proposed fund

is only intended to provide for operator default and

insolvency.

(b) Assuming a CSG rehabilitation fund is not established or only partly,

consideration be given to including a requirement in legislation or a

mandatory licence condition that the holder of a petroleum title take out and

maintain pollution legal liability insurance for certain CSG exploration and

all CSG production operations. At a minimum that policy should ideally

include coverage for identified pollution and natural resource damage,

cover the insured (and its operating subsidiaries) and all contractors and

other service providers on site, for example by nomination or as co-

insureds, cover actions and directions by Government (for example, to

remediate or rehabilitate a site or other area or resource) and extend

beyond a tenement or particular site.

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Given, as I understand, the market for such policies is only now developing,

some further work will need to be undertaken to determine the general

availability and cost of such policies.

It also does need to be recognised some operators may default in paying

premiums or in complying with insurance policy conditions, that ensuring

compliance by operators can be difficult, costly and time consuming for

responsible Government agencies and that in an area of such complexity it

is difficult to be overly prescriptive.

(c) Subject to one or other of the recommendations in (a) and (b) above,

security deposits in their current form be retained at least for the time being

(say two to five years) with the following qualifications:

• in particular cases the amount secured may be reduced and/or

apply to cover only on-site rehabilitation costs

• companies with a sounder financial record and backing, established

links to the State, a better operational and risk management record

and operating and planning to use more advanced technology (e.g.,

horizontal drilling; no or minimal fracking) and in areas of less risk

(e.g., no or minimal expected aquifer interference) could be

rewarded by paying a lower security or by being given the option of

providing another form of “financial assurance” (including insurance

as described above), possibly in combination with a minimum cash

or bank guarantee requirement.

(d) It will be evident that I do not recommend retention of the current security

deposit system on its own. As a separate exercise and subject to the

adoption of one or a combination of the schemes described above,

consideration be given to introducing a wider range and more flexible forms

of “financial assurance”.

(e) Finally, I note that with the possible exception of a CSG rehabilitation fund

no one security and risk management scheme or technique would seem to

offer a complete solution to dealing with the risk of CSG environmental

harm and liability.

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I think the recommendations above and my evaluation of their relative advantages

and disadvantages, more particularly as set out in the Attachment, will need to be

tested and should be critically reviewed. My observations and judgements are in

places necessarily subjective and impressionistic. I also think there is scope for

development of hybrid models, involving best elements of one or two schemes

especially over the short term, say over two to five years, and while the actual level

of CSG environmental risk is being assessed and more knowledge, data and

information are obtained.

4. Insurance

I deal with insurance in detail first in this paper because I was originally asked to

consider the types of insurance available to CSG participants and only later did our

inquiry extend to other risk management techniques.

4.1. Existing insurance arrangements

Marsh advises CSG risk in New South Wales (and Australia generally) is under-

insured and in some cases not insured at all. Other than as advised by Marsh and

another major insurance broking firm we have only limited information about the

actual level and specific types of insurance CSG industry participants do now carry

or will likely take out if their operations expand. I have also separately provided

you with a copy of a form of policy issued by Ironshore Specialty Insurance

Company titled “Site Pollution Incident Legal Liability Select (Spills) Oil and Gas

Form”, which I understand is generally available for oil and gas operations in the

U.S.A.. I think it would be helpful to collect more of this information.

Certainly it is clear there is no CSG industry standard approach to insurance and

according to Marsh little demand, except from several larger companies, for more

comprehensive insurance to cover CSG risk. I also understand several insurers

have been asked to quote on more comprehensive pollution liability coverage but

at this stage there has been no significant uptake of that kind of insurance cover.

As I understand, many CSG operators are likely to hold a third party liability (TPL)

policy which would generally have the following features:

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• it may extend to cover pollution but only if such pollution is characterised as

sudden, accidental, unintended, unexpected and happening at a specific

and identifiable time and place

• coverage does not generally extend to “natural resource damage”

• such insurance is generally only available to cover loss or damage to third

parties (i.e., it will not cover loss to the insured, in effect the “first party”,

and it may well be difficult for an insured to obtain appropriate insurance for

contamination to its land, for example under an industrial special risks or

property insurance policy)

• actions by regulators (including costs in complying with orders and

directions to restore or rehabilitate a site) are often not covered

• coverage of business interruption will generally only be available if the

pollution falls within the description above (i.e., sudden, accidental etc.)

• the level of coverage, although generally negotiable, may be inadequate

(as low as $5 to 10 million for smaller operators).

In particular, a TPL policy is not appropriate nor is it targeted to cover gradual

onset, off-site groundwater contamination, which is the main perceived risk of CSG

operations identified by the insurance industry.

Another type of insurance cover relevant to our inquiry is “operator’s extra

expense” or “control of well” cover, which has a specific application to “blowouts”

and the costs involved in regaining control of a wild or uncontrolled well, including

seepage, pollution and direct clean-up and containment costs. The trigger for

coverage is an unintended flow from a well of oil, gas, water, drilling fluids,

proppants and chemicals which cannot be stopped promptly, for example by a

blowout preventer. Again, however, the focus is on the consequences of a sudden

and accidental pollution event rather than addressing the effects of gradual

pollution and contamination. Separate and more specific coverage is also

available for drilling operations (e.g., loss of tools downhole).

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4.2. Pollution Legal Liability Insurance

Marsh advises some of the larger and more specialised insurers (e.g., AIG, ACE

and XL (Australia), Chubb, Lloyds, Ironshore and QBE (UK) and Zurich (US)) do

now offer more comprehensive, targeted and flexible pollution legal liability

insurance policies which indemnify CSG risk (including groundwater

contamination) and also have the following features:

• coverage can extend to most forms of pollution, both on-site and off-site,

and including both gradual and sudden events

• coverage can extend to natural resource damage

• coverage can extend to first party loss (e.g., the clean-up costs of an

operator and business interruption losses) as well as third party loss

• actions by regulators (including costs in complying with orders and

directions to restore or rehabilitate a site and other affected property) can

be covered

• typically, the main policy proponent is the permit/licence holder/operator

but contractors and other service providers can effectively be joined as co-

insureds or by nomination

• coverage can sometimes be available for civil/pecuniary penalties,

although this is problematic in Australia as such indemnity protection is

generally regarded as contrary to law or public policy (n.b., criminal fines

and penalties are not covered)

• coverage is available for $50 million plus.

Another advantage of a pollution legal liability policy (as opposed to a less flexible,

generic and cheaper TPL policy) is that it is generally only written if the insurer has

a better understanding and satisfies itself as to the insured’s claims history,

environmental record, planned operations, technical skills and supervision, and

systems of operation (e.g., risk management and use of latest technology and

drilling systems).

In addition, insurers under these policies:

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• typically require levels of risk to be more thoroughly assessed and

quantified (so far as that is possible) than would be the case for a TPL

policy

• and may be more vigilant in identifying risks which are excluded (possibly

giving the insured an opportunity to address or mitigate risks to obtain

coverage).

In effect, such insurance provides a limited self-regulation system with “penalties”

(i.e., higher premiums and the risk of policy non-renewal) if an insured does not

comply with policy requirements.

4.3. Statutory Requirements for Insurance and Financial Assurance

The POA does not include any requirement that the holder of any form of

petroleum title (including exploration licences (PELs), assessment leases,

production leases (PPLs) or special prospecting authorities) take out or maintain

insurance over the duration of the title and possibly also to cover a “tail” (in the

latter case if the policy is a “claims made” rather than an “occurrence” based

policy).

I think it would be helpful to interrogate both the OCSG and the Environmental

Protection Authority (EPA) whether, as a matter of practice or in exceptional

cases, insurance requirements are included in standard form PEL/PPL documents

and environmental protection licences, noting in the latter case section 72 of the

Protection of the Environment Operations Act 1997 (NSW) (the PEOA) does

provide as follows:

72 The conditions of a licence may require the holder of the licence to

take out and maintain a policy of insurance for the payment of costs

for clean-up action, and for claims for compensation for damages,

resulting from pollution in connection with the activity or work

authorised or controlled by the licence.

Even if such insurance is required it may not extend beyond on-site rehabilitation

and is unlikely to offer the same level of coverage as a pollution legal liability policy

of the kind described above.

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Section 571 of the Offshore Petroleum and Greenhouse Gas Act 2006 (Cth) (the

OPGGA) (amended in May 2013 – see schedule 3 to the Offshore Petroleum and

Greenhouse Gas Storage Amendment (Compliance Measures No. 2) Act 2013

(Cth)) goes further inasmuch as it provides that the holder of a petroleum title

must at all times while the title is in force maintain sufficient “financial assurance”

to meet costs, expenses and liabilities arising in connection with, or as a result of,

carrying out a petroleum activity, the doing of any other thing for the purposes of a

petroleum activity or complying (or failing to comply) with any requirement under

the OPGGA in relation to a petroleum activity. Examples given in the provision

itself include covering the cost of dealing with the escape of petroleum and

remediation of damage to the seabed or subsoil.

“Financial assurance” includes insurance and in addition self-insurance, bonds,

cash deposits with a financial institution, indemnities and other sureties, letters of

credit from a financial institution and mortgages (or any combination of these forms

of security).

In its context it seems such insurance is, potentially at least, a substitute for a

security deposit and, although financial assurance is compulsory and relates

generally to a “petroleum activity” for offshore petroleum (i.e., non CSG)

operations, it is possible such insurance may fall short of the coverage provided

under a pollution legal liability policy.

The PEOA (and the Environmental Protection Act 1994 (Qld)) also includes

detailed provisions for “financial assurance” as a condition of environmental

protection licences (and environmental authorities), although in each case the type

of financial assurance appears to be fairly limited (see, for example, section 298(2)

of the PEOA which refers to a bank guarantee, a bond and “another form of

security that the appropriate regulatory authority considers appropriate and

specifies in the condition” [of the licence]).

One generally acknowledged difficulty of mandatory insurance is that there can be

no guarantee operators will continue to pay their premiums or comply with policy

conditions. Ensuring the policy meets minimum standards of coverage can also

be problematic. To some extent this can be addressed by the threat of licence

cancellation or forfeiture but it does underline the need for “back-up” forms of

security, a matter considered in more detail in Part 5.

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4.4. Further observations on insurance

In this paper I was asked and have focused on the main types of insurance

available to CSG industry participants to protect against environmental risk and

damage, specifically pollution liability and third party liability insurance. A more

complete review of the topic would also include references to directors’ and

officers’, workers’ compensation, product liability and professional liability

insurance and a range of specialty policies available to drilling companies and

other service providers.

The range and complexity of insurance policies, including the scope to amend and

vary those policies with endorsements, exceptions and special wording and

drafting necessarily means insurance is difficult to regulate and the search for a

model form of insurance or suite of insurance products may well be elusive. It also

points strongly to the fact insurance is not a substitute for proper regulation nor a

complete solution to risk management in the CSG industry.

Finally, I note some industry participants could well argue in a particular case their

own insurance coverage, however inadequate it may seem to insurers and

insurance brokers, is sufficient, for example because they are only engaged in

limited exploratory work, observe safe and proven drilling and well integrity

practices and/or have a strong record of environmental compliance. In the case of

the larger companies (and especially the oil majors) they may also prefer to rely on

self-insurance or seek a larger excess on their policies. In such cases it may be

appropriate to cover the risk of those operators by other means, for example by a

higher security deposit or a different mix of financial assurance products (see Parts

4.3 and 5).

5. Security Deposits

Part 10A of the POA provides that the Minister may impose a condition requiring

the holder of a petroleum title to give and maintain a security deposit for the

fulfilment of the holder’s obligations under the Act in respect of the title (including

obligations that may arise in the future) and to maintain that security deposit until

those obligations are fulfilled (see section 106B(1)).

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The security deposit may be in such form as the Minister determines, although

typically a cash deposit or unconditional bank guarantee is required3. The

minimum amount for a security deposit is $10,000 (see Reg 24A, Petroleum

(Onshore) Regulation 2007 (NSW)).

One shortcoming of the security deposit model is that it likely does not cover the

rehabilitation of land which may lie at some distance from a petroleum title, a

matter which will need to be confirmed by OCSG. I also understand in practice the

rehabilitation of adjoining land is covered. That may be because the provisions

are largely based on or are at least similar to provisions in mining legislation (e.g.,

Parts 11 and 12A of the Mining Act 1992 (NSW)). The obvious point to make about

conventional mining and exploration, as opposed to unconventional gas production

and exploration, is the effects of the former are largely (but not always) confined to

the title or at least its immediate vicinity. That may not be the case with CSG

exploration and production, where if environmental damage occurs (e.g., escaped

chemicals, aquifer damage, the uncontrolled flow of produced water) its impact

may in fact be more damaging and costly well beyond the title and even its

adjoining land.

Despite the wide wording of section 106B(1) of the POA, as I understand, security

deposits are generally only required and available to cover estimated rehabilitation

costs on-site and to adjoining land with added amounts for project management

(10%), monitoring (5%) and contingency (10%) (see the Department of Trade and

Investment’s publication, ESG1 Rehabilitation Cost Estimate Guidelines).

As noted, the requirement for adequate “financial assurance” may also be included

in an environment protection authority issued under the PEOA. Such an authority

is required for CSG operations in addition to a petroleum title. (I do not know

whether as a matter of practice such financial assurance is required by the EPA if

a security deposit has been provided under the POA, although I know the practice

in some States is not to require more than one security deposit covering

_____________________________________________________________________ 3 As a rule NSW regulators have only accepted cash bonds or bank guarantees although there is limited scope for the

Minister to accept a security deposit in another form (see section 106B(1) of the POA). Further, section 1.3 of ESG1: Rehabilitation Cost Estimate Guidelines states Investment and Industry NSW is willing to accept other forms of security deposit proposed by industry provided there is no additional risk to the NSW Government, funds are available when required by the Minister and maintenance of the deposit is not dependent on subsequent actions by industry (e.g., periodic insurance instalments). I also note that Swiss Re International Ltd through Assetinsure Pty Ltd is presently seeking approval from the Australian Prudential Regulation Authority for a new form of (non-bank) bond which can be offered on an unsecured basis with deposits payable in instalments over a period of 5 years up to 50% of the bond amount, thereby freeing up working capital. Note also the requirements of NSW Treasury Circular TC 14/01 titled “Acceptance of Performance Bonds or Unconditional Undertakings by Government Agencies”.

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essentially the same risks.) This requirement appears both broader and more

flexible than the requirement in the POA for security deposits in so far as:

• financial assurance may take the form of a bank guarantee, bond or any

other form of security the EPA considers appropriate and specifies in the

licence as a condition; and

• given an EPA security deposit (if required) generally relates to an identified

project rather than to an identified title or titles it may extend beyond

remediation and rehabilitation of the site,

although both these comments would need to be checked and confirmed following

discussion with the OCSG and the EPA.

6. Special Purpose Fidelity Funds

6.1. Available securities

It will be evident from the analysis above that pollution legal liability insurance

provides a level of protection beyond that offered by compulsory security deposits,

more particularly as the main purpose of security deposits is only to provide for on

– site (and limited adjoining land) rehabilitation if the operator is in default or

insolvent.

Provisions in Queensland onshore petroleum legislation and Commonwealth

offshore petroleum legislation also suggest in many respects wide-reaching

“financial assurance” provisions can take the place of, or at least supplement,

more narrowly focused security deposit provisions.

6.2. Establishment of a special purpose fidelity fund

A further possibility is the establishment of a CSG rehabilitation fund similar to the

Mining Rehabilitation Fund (the MRF) established in Western Australia under the

Mining Rehabilitation Fund Act 2012 (WA) and commencing as recently as 1 July

2013.

The MRF replaces the current system of individual or mine specific bonds with a

rehabilitation fidelity fund supported by levies imposed on the industry.

In effect, tenement holders are now able (and from 1 July 2014 will be required) to

pay an annual non-refundable fee or levy equivalent to 1% of their rehabilitation

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liability to a central fidelity account administered by the WA Department of Mines

and Petroleum (the WADMP).

Some features and advantages of the MRF are:

• Pooling contributions to the MRF means the State (Western Australia) can

apply the fund to any long abandoned mine (or “derelict mine” as it would

be described in New South Wales) rather than relying on consolidated

revenue or a largely Government supported fund such as the NSW Derelict

Mine Sites Fund (see generally Part 11, Division 3A of the Mining Act 1992

(NSW).

• The fund is better suited to remediating off-site, cumulative and long term

environmental effects of mining and not just tenement or project specific

rehabilitation.

• In Western Australia it has been estimated only 25% of rehabilitation costs

are in fact covered by bonds and it is hoped the MRF will provide that State

with an opportunity to build up a fund of $500 million representing 100% of

its contigent rehabilitation costs. (I understand the position in New South

Wales is not so serious but this should be checked).

• The MRF has received widespread industry support with approximately

300 mining companies electing to participate in the voluntary one year “opt

in” period (FY 2013/2014), the reason being the MRF is regarded as

cheaper, in particular because it does not require operators’ capital to be

tied up in cash or cash-backed unconditional bank guarantees.

• Given most mining companies fulfil their rehabilitation and closure

obligations, in the usual case deposits are fully refunded. This also means

annual fees under the MRF over the life of a mine will likely only need to

equate to 8 to 10% of total estimated rehabilitation costs for individual

mines.

• Small operators are exempt (i.e., holders of tenements with a rehabilitation

liability estimate below $50,000 must report disturbance data but will not be

required to pay a levy to the MRF).

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• Each mining operator still has a statutory obligation to fund its rehabilitation

and closure costs, with the MRF only funding rehabilitation and closure on

sites where an operator cannot or will not do so.

I think a fund of the kind described above could be a very attractive alternative or

supplement to the current security deposit system operating in New South Wales

for CSG operators, especially as the main concern about such operations is off-

site, long term and cumulative effects of CSG operations, particularly in regard to

water management, aquifer interference and groundwater contamination, and not

immediate on-site physical damage. Indeed, it seems to me there is a more

compelling case for a CSG rehabilitation fund than a mine rehabilitation fund.

There is also a useful model or precedent for such a fund in New South Wales,

namely the Mine Subsidence Compensation Fund administered by the Mine

Subsidence Board. Another point of reference may be the US Comprehensive

Environmental Response, Compensation, and Liability Act (“CERCLA”), commonly

known as Superfund, which does however (controversially) include an oil and

natural gas exemption.

Very often security deposits are relied upon only at the point of mine closure and

when it is evident the operator will not be able to fulfil its obligations. A fund may

well be a better means of paying for ongoing and continuing costs of rehabilitation

and remediation (assuming the operator is obliged to but does not pay those

costs), including monitoring and necessary preventative work. It is also possible

the income earned by the special purpose fund could provide some or all of the

funds needed for such monitoring and preventative work.

It also seems to me that adoption of a CSG rehabilitation fund, especially if it is

structured to reward good oil field and environmental practices, will more likely

satisfy the Government’s own objective of “ecological sustainable development”

than the existing security bond system. The term “ecologically sustainable

development” is described in section 6(2) of the PEAA as requiring “the effective

integration of economic and environmental considerations in decision-making

processes” and along with the “precautionary principle” (referred to above) and the

principle of “inter-generational equity” relevantly includes a reference to the

following:

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(d) improved valuation, pricing and incentive mechanisms - namely, that

environmental factors should be included in the valuation of assets and

services, such as:

(i) polluter pays - that is, those who generate pollution and waste

should bear the cost of containment, avoidance or abatement,

(ii) the users of goods and services should pay prices based on the full

life cycle of costs of providing goods and services, including the use

of natural resources and assets and the ultimate disposal of any

waste,

(iii) environmental goals, having been established, should be pursued

in the most cost effective way, by establishing incentive structures,

including market mechanisms, that enable those best placed to

maximise benefits or minimise costs to develop their own solutions

and responses to environmental problems.

In its Preliminary Discussion Paper, Policy Options for Mining Securities in

Western Australia, December 2010, the WADMP envisaged as a further possibility

a combination of the two models (i.e., bonds and rehabilitation fund) and an

insurance model (see further below). The legislation (see above), however,

provides only for the rehabilitation model over the longer term. Two commentators

have proposed a hybrid scheme with bonds being retained alongside the MRF but

set at less than 100% of potential liability, their argument being the abolition of

bonds will effectively leave the State as an unsecured creditor of insolvent

companies which are unable to meet their mining rehabilitation and closure

obligations. In effect, the bond system could be retained as a baseline security

system which relates to a particular project or tenement identified as being at risk

(e.g., because of the financial strength or otherwise of the operator and particular

risks associated with the project itself) while the MRF provides a pool of funds for

remediating the cumulative and long term effects of mining4. By analogy, in the

case of CSG exploration and production a reduced security bond could be relied

only for immediate well site damage and the proposed CSG rehabilitation fund

could be used for remediating the cumulative and long term effects on the

environment beyond the well site or affected title.

_____________________________________________________________________ 4 N Somner and A Gardner, Environmental Securities in the Mining Industry: A Legal Framework

for Western Australia, 31(3) 2012 ARELJ 242

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6.3. Insurance for mine closure and rehabilitation

Finally, I note the WADMP rejected a third model which would have required

operators to take out and maintain insurance, with the State named as a

beneficiary and covering the full cost of government undertaking the closure and

rehabilitation of a mine site. The model was rejected because:

• evidence indicated such insurance may not be available in Australia (Marsh

advises that is no longer the case.)

• insurance policies are not unconditional (cf. bank guarantees) and are

typically subject to exemptions

• such insurance only remains current if premiums are paid (a matter

Government cannot easily control or supervise)

• policies may be cancelled or not renewed without reference to

Government.

To be clear, the rejection of this model should not be understood as a repudiation

of the proper and appropriate role of pollution legal liability insurance (as described

in Part 4) nor necessarily as a rejection of insurance as one component in a mining

security or as part of a financial assurance requirement.

Bernard Evans Partner, Hicksons Professor, University of Notre Dame Australia t: +61 2 9293 5480 f: +61 2 9293 5280 e: bernard.evans@hicksons.com.au 4 March 2014 (first issued on 7 November 2013)

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Bibliography

1. New South Wales Government Department of Industry and Investment, ESG 1 Rehabilitation Cost Estimate Guidelines, 2010

2. Government of Western Australia Department of Mines and Petroleum, Policy Options for Mining Securities in Western Australia Preliminary Discussion Paper, December 2010

3. Government of Western Australia Department of Mines and Petroleum, Mining Rehabilitation Fund Fact Sheet – May 2013

4. International Council on Mining and Metals, Guidance Paper: Financial Assurance for Mine Closure and Reclamation, 2006

5. The World Bank Group Oil Gas and Mining Policy Division, Guidance Notes for the Implementation of Financial Surety for Mine Closure, 2008

7518175.1:alt

ATTACHMENT TO PAPER 1 – INSURANCE AND ENVIRONMENTAL SECURITIES

RISK MODEL EVALUATION – INSURANCE AND ENVIRONMENTAL SECURITIES

Risk Technique/Strategy

Level of risk for Government

Administrative burden/complexity

Acceptance by Industry

Coverage of all Stakeholders

Extent of Coverage (1) – Past Incidents

Extent of Coverage (2) (tenement – specific or

broader?)

Capacity to reward good oil field and

environmental practices

Risk Identification1

1. Security Deposits Very low, if in the form of cash or bank guarantee. (The greater risk is likely to be the amount in a particular case may fall short of actual rehabilitation and remediation costs.)

Relatively straightforward, although that statement would need to be confirmed by the Department/OCSG.

Poor, industry dislikes payment of cash bonds and cash backed bank guarantees for mining/ oil and gas production but may accept lower security bonds for low-impact exploration (i.e., not involving pilot wells).

The security bond system is not intended to protect a wide group of stakeholders (e.g., farmers). Its purpose is more immediate – simply to cover the cost of direct site – specific rehabilitation and remediation costs in circumstances where the operator has not done so.

Given the short history of the CSG industry in NSW (i.e., as far as I am aware, the security bond system has always been in place for as long as CSG exploration and production has been undertaken in NSW), the greater risk is that available security bonds may be exhausted and, if that were to occur often, Government would be very exposed. One obvious objective of any risk control system would be to avoid such an outcome and in particular the need to establish a fund similar to the Derelict Mines Sites Fund, for derelict CSG well sites.

Tenement specific for security bonds granted pursuant to the Petroleum (Onshore) Act (POA)/a petroleum title, but may extend to adjacent/contiguous areas, although that would need to be confirmed by the Department/OCSG.

A security bond if required under an EPA licence is more likely to be project specific and therefore potentially have a broader application. Query whether and to what extent bonded funds would be available for remediation/rehabilitation well beyond a well site, a matter to be confirmed by the EPA.

The security bond system is, as I understand, fairly inflexible. (Again, however, that should be confirmed by the Department/OCSG/EPA).

In the case of security deposits, which are only intended to cover the cost of rehabilitation and remediation at or near a well-site this is unlikely to be an issue.

1 The intention of this column is to distinguish those cases where identification of the source or cause of environmental damage arising from CSG operations may be critical and may even defeat a recovery claim. For example, in areas where there is

more than one CSG operator or even different sources of pollution, it may be difficult, even impossible, to establish that a particular CSG operation caused downstream environmental damage.

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Risk Technique/Strategy

Level of risk for Government

Administrative burden/complexity

Acceptance by Industry

Coverage of all Stakeholders

Extent of Coverage (1) – Past Incidents

Extent of Coverage (2) (tenement – specific or

broader?)

Capacity to reward good oil field and

environmental practices

Risk Identification1

2. Other forms of financial assurance (e.g., self-insurance, indemnities and securities, parent companies guarantees, mortgages etc.)

Assuming the more flexible forms of security (e.g., a parent company guarantee) were only available to larger operators with a proven record of environmental performance this may not be a significant issue. Protection could include requiring the proponent to make out its case for another form of financial assurance based on its capitalisation, links to the State, record of environmental compliance etc. and sanctions for breach could be swift and immediate (restoration of a cash bond/guarantee on breach and threat of licence withdrawal).

Relatively high, but possibly not while the NSW CSG industry is small and there are only a few operators.

High. I expect widening the range of financial assurance choices available to industry would be very welcome.

Properly managed, any widening of financial assurance choice should not affect or concern other stakeholders. However, to allay concerns one possibility may to require higher levels of cost coverage the less secure the type of financial assurance chosen. So, for example, an insured, indemnified or non-bank guaranteed amount may be twice the bond amount or even in some cases unlimited.

As above, except to the extent more flexible financial assurance provisions, if sufficiently secure, may give greater coverage.

As above Flexibility should provide scope to reward good practice.

As above

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Risk Technique/Strategy

Level of risk for Government

Administrative burden/complexity

Acceptance by Industry

Coverage of all Stakeholders

Extent of Coverage (1) – Past Incidents

Extent of Coverage (2) (tenement – specific or

broader?)

Capacity to reward good oil field and

environmental practices

Risk Identification1

3. Pollution legal liability insurance

Insurance as an alternative to security bonds has traditionally been seen as unacceptable. There are other risks with insurance – understanding and interpreting policies; difference in policy coverage and exemptions; defaults in premium payments etc. On the other hand, an appropriate and comprehensive pollution liability insurance policy which includes voluntary and mandated clean-up costs could offer a level of indemnity greater than that provided by a security bond or other form of financial assurance.

Administration and supervision of an insurance scheme will be complex.

Unknown, although there is anecdotal evidence large operators are seeking out such policies. To add to the uncertainty we have no information about the likely level of premiums insurers will charge for such insurance.

This is a clear advantage of a pollution legal liability insurance policy. The insured can potentially include the operator and its subcontractors and service providers on site and provide coverage to a wide range of third parties including landowners, affected businesses and even Government.

Insurers for reasons which are obvious enough will not generally underwrite past incident risk and in any case an insured’s duty to disclose may effectively preclude such cover. No coverage for past incidents will be available under an “occurrence” based policy. (Pollution liability insurance is typically “claims made” although “occurrence” based insurance is available to drillers.)

Insurance of this kind can extend well beyond a tenement to cover pollution that migrates off site.

As we understand, premiums offered under insurance of this kind will be highly dependent on good oil field and environmental practices both on application and on annual renewal.

Disputes as to the immediate cause of environmental damage, especially if off-site, are likely as insurers may be keen to deny liability or seek contribution.

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7518175.1:alt

Risk Technique/Strategy

Level of risk for Government

Administrative burden/complexity

Acceptance by Industry

Coverage of all Stakeholders

Extent of Coverage (1) – Past Incidents

Extent of Coverage (2) (tenement – specific or

broader?)

Capacity to reward good oil field and

environmental practices

Risk Identification1

4. CSG Rehabilitation Fund

Government will be most exposed in the early years of the proposed fund (as capital in the fund grows) and also in the event of operator insolvency. Three possible resolutions are:

(1) to retain security deposits for immediate well-site remediation/rehabilitation only (and in a lesser amount) as baseline security;

(2) to retain security bonds for inherently more environmentally sensitive projects and/or in cases where operators cannot meet a prescribed capital adequacy requirement; or

(3) phase in the fund over 2 to 5 years and retain the bond system with a progressive return of funds to operators.

Difficult to assess but note that the Mine Subsidence Compensation Fund is a model. Some intelligence could also be obtained about the Western Australian experience with its recently established Mine Rehabilitation Fund.

High, if the reported reaction to the Western Australian mine rehabilitation funding scheme is correct.

Yes, this scheme should appeal to all stakeholders although one would expect there will be concern about its capital adequacy, especially in its early years.

As I see it, coverage of past incidents is one of the best reasons for establishing a CSG Rehabilitation Fund (thereby hopefully avoiding the need for a consolidated revenue funded fund.) The significant point is funds can be deployed to remedy/rehabilitate land and other resources affected by CSG operations, whenever undertaken.

Again, the proposed CSG Rehabilitation Fund should offer coverage well beyond a well site.

If properly administrated there may be capacity through setting lower annual levies for proven good practice and performance. Query however the extent to which levies of this kind, which may not be significant compared to overall operating costs, can in fact influence behaviour.

No issue of identifying the source of CSG contamination should arise at least so far as ensuring the necessary rehabilitation remediation work is done. (For other purposes – setting an annual levy, example – such identification may be necessary.)

APPENDIX 3 PEER COMMENT ON “INSURANCE AND ENVIRONMENTAL SECURITIES”, BY TONY ABBOTT, PIPER ALDERMAN

28755320v1

Environmental risks arising from CSG operations

Environmental Risk Likelihood of Occurrence Consequences of

Occurrence

Existing Legislation Controls Primary risk control

measures

Secondary control measures Role for

(a) Security Deposit

(b) Insurance

(c) Rehabilitation Fund

Pollution occurring above

ground

Some examples have occurred

in NSW of overflow/spillage of

produced water / drilling fluids,

being (typically brine solutions)

Total number of incidents not

known

Effective make good and

restoration normally possible

by conventional methods with

low risk of permanent

environmental damage

(a) Breach of licence / lease

conditions under PO Act

and/or direction to make

good

(b) Breach of CLM Act

(c) Breach of licence issued

under the POE Act

(a) Requirement for prior

approval of Water

Management Plans

approval detailing water

management treatment

and disposal methods as

a condition of CSG

activity approval

(b) Containment measures /

bunding requirements

limiting area of exposure

(c) Requirement to

physically make good

(d) Risks reduced by

banning of evaporation

ponds

(e) Temporary ponds

required to meet strict

standards of construction

and freeboard

(a) Verification and

monitoring of primary

control measures

effectively in place prior to

activity commenting

(b) Requirement of operator

to regularly inspect and

report status during CSG

activities

(c) Ability to require

cessation of CSG activity

/ elimination of risk by

direction under PO Act if

risk dete